It seems that most if not all advanced economies (US, Japan, UK to name a few) have been running budget deficits since basically the last 20 years. I understand that current debts lose value over time because of inflation and economies grow, but how can they do this for basically ever? I can’t wrap my head around the maths that makes this possible, and the markets don’t seem all that worried
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Governments can just print fiat money and pay for whatever they like (or they *could* if they didn’t follow their own self-imposed rules.)
However, printing lots of money with no regard to the strength of the economy is a one-way ticket to hyperinflation.
So, in order to be able to spend lots of money without just printing it, the government pulls out of the economy about as much money as it puts in. It does this in two forms: taxes and borrowing.
Taxes reduce the supply of money by directly taking a portion of the money used in economically valuable trades. People are going to do these trades anyway because the value of the trade is worth *more* to both sides than the amount of tax being paid. This is all good but too much tax (or an ineffective tax model) may prevent people from making otherwise good trades that would have had a net benefit for the economy.
Borrowing also reduces the supply of money by allowing people to commit to locking up their long-term wealth, ensuring that it doesn’t flood the market and cause inflation. In return, these people will be paid some interest, which is better for them than nothing. This allows the government to lower taxes and promote economic activity, but at the cost of servicing this debt over time. However, since most governments are actually targetting a low but non-zero level of inflation anyway, this cost ends up not mattering to them all that much if they only borrow an amount that they can afford to.
Of course, it’s also possible to borrow too much and end up in a situation where servicing your debt becomes too expensive. You end up needing to spend less, tax more, print more money, borrow more or default on your loans (and/or lie about how bad the situation really is.) Any of these options will devalue your currency and/or increase cost of borrowing, which only makes your financial situation worse and can ruin your economy for decades. This is more or less what happened to Greece in 2009.
However, if you borrow a sensible amount, your cost of borrowing remains low and it’s a very effective tool both for locking up money short-term so that you can spend a lot (on, hopefully, things that will strengthen your economy) and for building long-term confidence in your government.
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